Cuba's foreign investment invitation may hide potholes

CNBC's Michelle Caruso-Cabrera takes a look at Cuba's new foreign investment law which will allow the existence of foreign-owned businesses.

Cuba is expected to approve a new law that in theory will draw more foreign investment to the socialist country. But in practice, critics argue, it will be insufficient to assuage investor concerns about their money.

According to the proposed law, a copy of which has been seen by NBC News, fully foreign-owned firms will be permitted, and taxes will be either lowered or eliminated for some time. Additionally the taxes will be streamlined to cover net income rather than labor.

Washington attorney Jason Poblete says Cuba still lacks two of the bedrocks of investing: rule of law, and protection of property rights.

"You need a stable legal system that protects investor rights and has a path to resolve disputes," said Poblete, who represents American clients with claims against Cuba stemming from the mass nationalization of private property in the early 1960s, after Fidel Castro took control of the island in a 1959 coup d'etat.

Fully foreign-owned firms

Justin Solomon | CNBC

Theoretically, fully foreign-owned businesses have been permitted, but were never actually approved. Until now, the government insisted on joint ventures, in which they were the controlling partner with a more than 50 percent stake. Inability to control an investment has been a large hurdle to foreign direct investment.

In private conversations in recent years, government officials told CNBC this would change when the new law was implemented. It remains to be seen whether or not they will actually allow it to occur.

The law also seeks to dramatically lower taxes. Currently, the few foreign firms doing business in joint ventures with the government must pay taxes of 30 percent on all profits and 20 percent on labor. Under the proposal, the mining profit tax will drop to22.5 percent from 45 percent. The labor tax would be eliminated and the tax on profits will drop to 15 percent.

The Cuban parliament will vote on the proposed new foreign investment law Saturday.

Cuban exiles yes, Cubans no

One provision says Cuban exiles may invest, but Cubans living in Cuba cannot.

It's not atypical for the Cuban government to create regulations that treat Cubans differently than non-Cubans. For example, Cubans who live in Cuba are prohibited from entering certain hotels and restaurants where foreign tourists are permitted to stay. Poblete says the new law enshrines "investment apartheid like their tourism apartheid."

Ted Henken of Baruch College sees great irony in the clause: "It creates second-class economic citizenship compared to the 'evil exiles.'"

Henken believes the clause is designed to incentivize Cuban exiles to lobby the United States for an end to the embargo. Right now, even if Cuba allows exiles to invest, the United States prohibits its citizens from doing any business in Cuba. And while exiles are allowed to send money to their relatives on the island, the structure of the U.S. law means that money can't be used to invest. The U.S. started its embargo against Cuba more than 50 years ago in protest of Castro's communist polices.

Outstanding claims a problem

Another hurdle is the issue of outstanding claims against the island. There are still billions of dollars in outstanding claims from the early 1960s when Castro seized every business in the country, eliminated private property and decided that every citizen would work for the government. One of the clauses in the U.S. embargo is that outstanding claims held by American citizens must be resolved.

Poblete says when his firm learns of a foreign company trafficking in or on a disputed property, he files a claim with the U.S. government. "What's the European investor going to think? Do I want to fight off the U.S. State Department?"

Why now?

Since 2010, the Cuban government has made incremental economic reforms. For example, in certain categories of employment, individuals are now allowed to work for themselves and not the government. The pace of reforms increased in the past year, when the government announced employees could take over failing government operations in certain categories such as transportation, and try to make a profit, which they then would split with the government 50-50.

Henken believes it has to do with the unrest and instability in another socialist Latin American country. "They can't rely on Venezuela for their ace in the hole," he said. The oil-producing, OPEC nation provides more than 100,000 barrels of deeply discounted oil per day to Cuba. It's a crucial subsidy that keeps the lights on and cars on the road. But recent unrest in Venezuela raises questions about its stability and the long-term viability of the oil handout.